There’s no easy way to say this. Right now, the government’s economic policy is on a collision course with ballooning private debt and a meltdown is hurtling toward us as certain as night follows day.
To use a popular metaphor, as things stand, the frog is well and truly in the saucepan, the hotplate is on full, the water is getting uncomfortably warmer and the frog still hasn’t realised he is in deep trouble.
That is the best way I can think of to describe the current state of private debt and what is going to happen a little further down the road without some drastic intervention.
Since the Howard/ Costello years of fiscal surpluses when private debt hit the ceiling to offset them, the situation for households has become steadily worse and about to head through the roof.
Today, mortgage interest payments are at the same level as they were in 1989. Yet, today’s average mortgage rate is 5.2% compared with 17% in 1989 and mortgages today are ten times greater than they were in 1989.
If that doesn’t jolt you to the reality of the situation try this: Australian households are now one of the most heavily leveraged in the world. In 1990, household debt accounted for about 60 per cent of income. By 2013, it had risen to 180 per cent; and the reason is mortgages.
In April 2015 owner occupiers alone borrowed $9.8 billion. Investors borrowed $11.5 billion. Australians currently owe $1.4 trillion in mortgages.
It is in this fragile environment that Joe Hockey wants us to go out and borrow. He wants young people to get a good job that pays good money and to build, build, build. Effectively, he is asking them to turn on the hotplate, jump into the saucepan and pay no attention to clowns like me out there warning of what happens when the water boils.
There is one sure way to know if he is sincere in what he urges us to do and that is to ask: is he and his government doing the same? No, they are not. They are cutting back on anything they can get away with and then some. They are selling assets to get back to surplus. That means only one thing for consumers….more private debt.
The principle is simple. When governments spend more than they collect in taxation, consumers are able to save. When governments spend less than they collect in taxation, consumers are forced to take on debt.
The government is currently spending more but their policy is to cut back further to the point where taxation receipts are greater than outgoings. If they succeed, the private sector will go deeper into debt.
If Joe Hockey was to set the right example and do what he is asking of us, his fiscal policy would be to spend more….lots more, not less. If he wants us to spend, government should be spending too, thus enabling us to spend and save.
With interest rates at record lows, the temptation to borrow is strong. Similarly, the banks are more than happy to lend, based on your ability to meet your mortgage payments. But what happens when interest rates and consequently mortgage payments, start to rise again?
It’s not rocket science. In a recent blog, Bill Mitchell warns, “The other point is that with the massive debts already being carried by home buyers, the situation will become worse when the RBA, at some point, starts pushing up rates again and house price rises start to taper.”
Already, most home mortgage payments require two incomes. With wages growth flat lining, where will the extra money come from when rates begin to rise? These higher payments will only lead to greater mortgage stress which will, in turn, impact on private spending right down to essentials such as food, clothing, power, etc.
Reduced spending will impact on employment be it casual or full time and that will threaten the two income household first.
It will also impact on the banks. Depending on the margin between what banks have lent and the value of the property the loan covers, they stand to lose in a big way. A burst property bubble means a collapse in values rendering their loan securities highly vulnerable.
They will act quickly and brutally, demanding loans be called in, or additional security offered. What highly leveraged home owner with just one income and children to care for, will have that?
Australia avoided the personal devastation of a property Armageddon post GFC, unlike our cousins in the USA, Europe and the UK who are still recovering. We are yet to feel their pain. But the reality will dawn on us sooner rather than later. It’s a case of when, not if.
I am not a financial adviser and without prejudice think the best advice for those trying to get into the market is to save but don’t buy. Wait a year or two for the bubble to burst when housing affordability will be a reality.